Starting to buy the Donald dip

Trevor Greetham

6 February 2018

Stock markets fell sharply after US wage inflation hit its highest level since 2009, triggering fears that the US Federal Reserve (Fed) will need to raise interest rates more rapidly than expected. The sell off was exacerbated by the frothy level of investor bullishness beforehand and the severity of the downward move suggests forced selling by risk parity funds and other leveraged investors, with the VIX index of US stock market volatility seeing its largest ever one day increase (Chart 1).

To keep things in context, the sell off to date merely reverses part of the December/January rally in stocks. The world economy is growing strongly, corporate earnings are being upgraded, equity market valuations are less heady and we’re seeing a total clearing out of bullishness. Our composite sentiment indicator is heading for its most negative reading since the China devaluation panic of summer 2015 (Chart 2).

The sell off in stocks looks like an overreaction. We expect bouts of volatility to become more common now the Fed is in play but expect stocks to recover over the coming weeks and months as the economy continues to expand. Yes, rising interest rates are a challenge to the stock market but only a serious one once they are high enough to cause the economy to roll over. With the Fed Funds rate still below core inflation, that could take quite a while (Chart 3).

We lightened up equity exposure in some funds early last week, while remaining overweight equities. We are buying again at lower levels this week.

Chart 1.

Source: Bloomberg.

Chart 2.

Chart 3.

Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.